The new thing put out by Amazon.com (AMZN) a couple of days ago, is how it's setting up this new service called Pantry. Pantry is a service where Amazon.com provides you with a box and a weight limit, and you can use it to buy bulk grocery items. This service is supposed to bring the fight to Costco (COST).
The whole thing is deeply unrealistic
It's not that Amazon.com can't make it work. But people seem to be wildly unaware of just how uncompetitive Amazon.com is, when faced with Costco. Uncompetitive in terms of cost. Costco has cut cost to the bone, massively beyond anything Amazon.com can reach. This is entirely obvious to anyone familiar with the Profit & Loss statements of both companies. Here are just a couple of facts taken from these statements (last 12 months):
- Gross shipping costs are 10.5% of product sales (the category where this new program would fit in);
- Fulfillment costs (pick, packing, paying and warehousing) are 11.3% of revenues (this includes both product sales and service revenues);
- Technology costs plus marketing plus G&A are 14.2% of revenues.
- All selling, general and administrative costs are 9.6% of revenues.
See the problem? Amazon.com has more than 3 times the selling, general and administrative costs of Costco. Just shipping the product out to the customers exceeds Costco's entire cost base. And the picking, packing, paying and warehousing the products also exceeds Costco's entire cost base. And technology plus marketing plus general and administrative costs also exceeds Costco's entire cost base.
The two companies' pictures are at extremes to each other
While Amazon.com trades for 1411 times past 12 months' earnings and 531 times 2013 earnings estimates, Costco trades for 25 times past 12 months' earnings estimates and 24 times FY2014 earnings estimates.
This valuation chasm is in place though it is obvious that Costco is a massive cost leader over Amazon.com, as seen previously. Thus, while Amazon.com will remain challenged to increase profitability, Costco will continue chugging along in its low-cost, decent-margin strategy.
It's thus evident that Costco is structurally sounder to Amazon and has nothing to fear from Amazon's possible entry into its market. Yet Costco - the superior company - trades cheaper both on a P/E basis as well as in absolute market capitalization. Costco is worth $51.5 billion, whereas Amazon.com towers at a massive $180 billion in spite of its earnings and cost challenges.
In short, Amazon.com has no chance of competing with Costco on cost. It might try convenience or something else, but in terms of cost Amazon.com is a world apart from Costco. There seems to be the feeling that online retailers are somehow most cost-efficient. They aren't. Sure, online retail might menace niche retailers due to concentrating demand from a wide area and from cost being less of a driver, but when it comes to general high-volume merchandise, online retail doesn't stand a chance.
There's a reason why general merchandise mail-order catalogs (Sears Catalog, Montgomery Ward) lost out to bricks & mortar retailers long ago, while niche catalogs survived. The reason is economics. The reason is cost.
Additional disclosure: I have an options position which stands to gain from AMZN dropping.